FUJITSU PC ASIA PACIFIC LTD v. TECHNIQUE COMPUTER SYSTEM (HK) LTD AND ANOTHER

HCA 1422/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1422 OF 2003

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J U D G M E N T

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1.  The Plaintiff is a creditor who claims in this Action to be entitled to repayment of the principal sum of $2,346,450 and accrued interest of $1,363,512.45 from 1 July 1997 to the date of the Writ.  The 1^st Defendant is the principal debtor and the 2^nd Defendant the guarantor.

2.  The principal sum represents certain trading debts arising from the supply by the Plaintiff to the 1^st Defendant of computers and computer accessories.  On 29 May 1996 the Plaintiff, through its solicitors, demanded payment of the sum then due.  As of July 1996, the outstanding indebtedness, including interest, amounted to $3,146,450 (“the Debt”).

3.  An agreement (which is referred to as the “No-Action Agreement” in these proceedings) was made between the Plaintiff and the 1^st Defendant.  The No-Action Agreement was set out in a letter dated 4 July 1996 and was signed by the 2^nd Defendant on behalf of the 1^st Defendant.  The terms of the agreement are material and I will set them out in full:

“1) TCS [the 1^st Defendant] agrees to settle the current outstanding debt due to FITA-HK [the Plaintiff] amounting HK$3146450 monthly starting from July 96.  The first payment will be payable by TCS on/before 31 July 1996 upon signing of this agreement by both parties.  …..

2) The said monthly settlement amount paid by TCS to FITA-HK should not be less than HK$100000 payable by cheque or other payment method as informed by FITA-HK.

3) Without any prejudice, FITA-HK agrees to hold legal actions against TCS provided there is a personal guarantee provided by the undersigned and there is no settlement in default as described in point 2 in any tow consecutive months.

4) TCS intends to settle the whole sum HK$3146450 by 30 June 1997.  Should there be any outstanding amount left at 30 June 1997, TCS agrees to pay FITA-HK interest at 10% per annum on the outstanding amount until the debt is fully settled.”

4.  In compliance with the condition of the No-Action Agreement, the 2nd Defendant signed a letter of guarantee dated 4 July 1996 in favour of the Plaintiff (“the Guarantee”) in the following terms:

“Technique Computer System (H.K.) Limited (TCS) currently owes Fujitsu ICS Trading Hong Kong Limited (FITA-HK) HK$3146450.

Further to our meeting earlier today, I hereby personally undertake to pay the said sum HK$3146450 (or any balance left) to FITA-HK if the aforesaid sum could not be fully settled by TCS according to attached agreement made between FITA-HK and TCS on 4 July 1996.

Based on my undertaking as above, FITA-HK agrees to hold the legal actions against TCS unless there is any monthly settlement in default in 2 consecutive months by TCS as per attached agreement and/or any breach of the agreement made by TCS.”

5.  I pause to observe at this point that although clause (4) of the No-Action Agreement was expressed as an intention to settle the whole sum by the date stipulated, both parties are content to regard it as an obligation for the 1^st Defendant to make repayment by that date: Plaintiff’s Skeleton Argument, paragraph 17; 2^nd Defendant’s Skeleton Argument, paragraph 26.  The distinction may well have a bearing on the nature of the obligation assumed by the 2^nd Defendant under the Guarantee.  But as neither party has raised or addressed the point, I would proceed with this judgment according to the common understanding between the parties.

6.  The 1^st Defendant repaid only $750,000 between July 1996 and 30 June 1997 and had therefore failed to repay the entire Debt by the latter date.  On 31 March 1999, the outstanding principal was $2,346,450.  Despite the Plaintiff’s demand for repayment by its letter dated 21 April 1999, the said sum as well as the accrued interest remained outstanding. 

7.  The Writ in the present Action was issued on 22 April 2003.  Default judgment was entered on 12 November 2003 against the 1^st Defendant.  The Plaintiff is now pursuing the 2^nd Defendant as guarantor. 

8.  In the present application, the Plaintiff seeks the Court’s determination of the following questions under Order 14A, namely:

“Whether on the proper construction of the Guarantee dated 4 July 1996 between the Plaintiff and the 2^nd Defendant:

(a) the Plaintiff’s right and entitlement to sue upon the Guarantee accrued on or after 30 June 1997 by reason of the Debt not having been fully settled by that date; and

(b) the Plaintiff was legally obliged to issue a demand to the 1^st Defendant and/or 2^nd Defendant to repay the outstanding balance of the Debt prior to the commencement of this Action to avoid the 2^nd Defendant being discharged from the Guarantee.”

9.  In the event of a determination of the 2 questions in favour of the Plaintiff, the Plaintiff further seeks summary judgment against the 2^nd Defendant on the Debt pursuant to the Guarantee.

10.  In the present application the arguments focused mainly on 3 issues:  the defence of limitation; the discharge of the guarantor’s liability under the guarantee; and the collateral agreement between the Plaintiff and the 2^nd Defendant. 

Defence of Limitation

11.  The question of limitation turns on the interpretation of the Guarantee.  Mr. James, for the Plaintiff, drew attention to the following sentence:

“….. I hereby personally undertake to pay the said sum HK$3146450 (or any balance left) to FITA-HK if the aforesaid sum could not be fully settled by TCS according to attached agreement made between FITA-HK and TCS on 4 July 1996.”  (emphasis added).

Emphasing the words highlighted above, Mr. James argued that the cause of action against the 2^nd Defendant did not accrue until 30 June 1997, being the last day by which the Debt was intended to be fully repaid under clause (4) of the No-Action Agreement.  

12.  In answer, Mr. Au for the 2^nd Defendant contended that the Plaintiff’s cause of action against the 2^nd Defendant accrued as soon as the 1^st Defendant was in default for 2 consecutive months under the No-Action Agreement.  In the event of such default, the entire indebtedness (less any repayment) became due under clause (3), which in turn triggered the liability of the 2^nd Defendant under the Guarantee.  With reference to the repayment records and the demand letters issued by the Plaintiff in the latter part of 1996 and early 1997, Mr. Au argued that the 1^st Defendant had already been in default for 2 consecutive months as early as September 1996, and in any event, by March 1997 at the latest.  Hence, when the Plaintiff commenced the present Action in April 2003, it was already time-barred.

13.  Mr. Au argued that the words “could not be fully settled” should be read together with “according to attached agreement”.  Hence, if and when the Debt was not fully settled in accordance with the No-Action Agreement – that is, when 2 consecutive months’ default occurred – the 2^nd Defendant’s liability to make payment under the Guarantee accrued.

14.  I do not agree with Mr. Au’s construction of the Guarantee.  I think the phrase “fully settled … according to attached agreement” is a clear reference to clause (4) of the No-Action Agreement.  While the effect of clause (3) is undoubtedly to enable the Plaintiff to take legal action as soon as the 1^st Defendant is in default for 2 consecutive months, the only express reference in the No-Action Agreement to “full settlement” of the Debt is clause (4).  My view is that the parties, by their specific reference in the Guarantee to “full settlement”, had intended that liability of the 2^nd Defendant should only accrue if and when the 1^st Defendant failed to effect full settlement of the Debt by 30 June 1997 in contravention of clause (4) of the No-Action Agreement.

15.  I would accordingly answer the first question in favour of the Plaintiff.

16.  In view of my conclusion on the construction of the Guarantee, it becomes unnecessary for me to consider whether, and when, the 1^st Defendant have been in 2 months’ default.  But had it been necessary to do so, the question would have been complicated by possible argument that even if there had been 2 months’ default by March 1997, the Plaintiff’s acceptance of repayment thereafter could have amounted to a waiver of its right to take action against the 1^st Defendant on the basis of such defaults.  Should that be the case, the Plaintiff would likewise not be entitled to commence action against the 2^nd Defendant until fresh 2-month defaults occurred.  Neither party has addressed the point in argument, and in the event, as noted above, it is unnecessary for me to determine the question.

Defence of Guarantor’s Discharge

17.  As presently framed, the second question focuses on the necessity of a demand on the 1^st Defendant and/or the 2^nd Defendant before commencement of the Action.  However, as it became clear in the course of the argument, Mr. Au did not contend that a prior demand was necessary to complete the Plaintiff’s cause of action.  Nor was it Mr. Au’s contention that a demand was required as notification to the 2^nd Defendant of the principal’s default.

18.  Instead Mr. Au argued that upon the 1^st Defendant’s default in July 1997 (for failing to make full payment), the Plaintiff became entitled to enforce the Guarantee and ought to have done so promptly.  By delaying enforcement, the Plaintiff had prejudiced the position of the 2^nd Defendant: first, by allowing interest to accrue on the outstanding principal sum; and secondly, by rendering the 2^nd Defendant’s right of subrogation valueless because the 1^st Defendant had eventually ceased trading in early 1999.  On the latter point, Mr. Au argued that if there had not been delay in the enforcement of the Guarantee, the 2^nd Defendant could have sought recourse against the 1^st Defendant from its available assets even as late as middle or late 1998 when the 1^st Defendant was still a going concern.

19.  Mr. Au referred to Watts v. Shuttleworth (1860) 5 H. & N. 235 where Pollock C.B. said at pp. 247-248:

“The substantial question in the case is, whether the omission to insure discharges the defendant, the surety.  The rule upon the subject seems to be that if the person guaranteed does any act injurious to the surety, or inconsistent with his rights, or if he omits to do any act which his duty enjoins him to do, and the omission proves injurious to the surety, the latter will be discharged …. [The] rights of a surety depend rather on principles of equity than upon the actual contract.”

The above passage was adopted by the Privy Council in China and South Sea Bank Ltd. v. Tan Soon Gin [1990] 1 A.C. 536, and by Waung J. in Fuji Bank Ltd. v. Sanko Air-Conditioning Engineering Ltd. [2002] 1 HKC 468 who said at p. 475:

“The reference to the three situations of (1) creditor did no act injurious to surety; (2) creditor did no act inconsistent with the rights of surety; and (3) the creditor did not omit any act which his duty enjoining him to do, suggests that the Privy Council approved the principle that a creditor was entitled to do many things so long as they did not include the three acts that I have referred to above.”

20.  Mr. Au relied in particular on the third of the three situations mentioned by Waung J. in the Fuji Bank’s case.  Mr. Au made it clear that he was not contending for a general proposition that as soon as the surety had incurred liability under the guarantee, a duty would arise requiring the creditor to take prompt enforcement action.  That Mr. Au recognized would have been too onerous a duty on the creditor and unwarranted as a matter of law.  What Mr. Au contended was that a duty to take prompt enforcement action did arise in light of the peculiar circumstances of the present case because, first, it was within the Plaintiff’s knowledge that the 1^st Defendant was a trader; second, that the Plaintiff knew, at the latest by July 1997, that the 1^st Defendant was unable to pay the full sum but it was still carrying on business; third, the Plaintiff knew or must be taken to know about the 2^nd Defendant’s right of subrogation; fourth, the Plaintiff would have known that had enforcement action been taken, the 2^nd Defendant could have discharged the outstanding indebtedness and have recourse against the 1^st Defendant which at the time was still a going concern with some assets.

21.  Mr. Au invited me to have regard to the facts of the Fuji Bank’s case (supra).  Fuji Bank was an appeal against a summary judgment granted in favour of the bank.  In that case the guarantors guaranteed certain overdraft and trust receipt facilities of the borrower.  Pursuant to the terms of the facilities a deposit of $2 million was pledged with the bank.  The borrower’s complaints were that despite request, the bank did not set off the deposit (which earned a lower rate of interest) against the outstanding indebtedness (which attracted a higher interest rate), and that the bank had unilaterally moved money which had been paid into the accounts with large overdrafts to the trust receipt account.  Mr. Au emphasized that even where the Court, in that case, had accepted that the banking documents did not impose any obligation on the bank to set-off and that as a general rule, the bank could enforce its security at any time it chose, the Court nevertheless held that an arguable case was made out that the bank’s failure to set-off the deposit was injurious to the guarantors’ interest.  

22.  I do not consider the Fuji Bank’s case is of much assistance to the 2^nd Defendant here.  We are clearly looking at a very different factual scenario in our present case.  In Fuji Bank, the learned judge remarked upon the unfair position of the difference in spreads which the bank had knowingly taken advantage of and that the facts in that case had presented him with “an exceptional situation”.  Here, the “peculiar circumstances” identified by Mr. Au are in fact quite commonplace. 

23.  Further, as is accepted by Mr. Au, it is well-established that a creditor does not owe a general duty to the surety to take prompt enforcement action:  O’Donovan & Phillips, The Modern Contract of Guarantee (Eng. Ed.), 2003, para. 10-107.  The principle applies to situations “even if the principal debtor becomes insolvent during the delay and the guarantor is thereby prevented from effectively exercising his right of indemnity against the debtor.”

24.  Further still, it cannot be said that the 2^nd Defendant was prejudiced because he was at the Plaintiff’s mercy as to the timing of taking enforcement action.  As Mr. James pointed out that upon the principal’s default in July 1997, the 2^nd Defendant as guarantor was well entitled “to remove the cloud” by discharging the outstanding indebtedness and then seek indemnity against the 1^st Defendant. 

25.  For the reasons aforesaid, I do not see any basis in the present case, whether factually or legally, for displacing the general rule set out in paragraph 23 above.

26.  The 2^nd Defendant’s other complaint concerns the accrual of interest resulting from the Plaintiff’s inaction.  To consider this question, one should first have regard to the wordings of the Guarantee itself.  By the Guarantee, the 2^nd Defendant has undertaken to pay the sum $3,146,450 or the outstanding balance if the “aforesaid sum” could not be fully settled by the 1^st Defendant.  The “aforesaid sum” in the context must be a reference to the principal, $3,146,450.  There is no reference to interest.  As a matter of construction, I think it is certainly open to the 2^nd Defendant to argue that the obligation he has guaranteed relates only to the principal and not the contractual interest that may have accrued under the No-Action Agreement.  If that is the correct construction, the 2^nd Defendant is not prejudiced by the alleged delay of the Plaintiff in taking enforcement action.  

27.  Even if I am wrong on the construction and the obligation guaranteed indeed includes interest, then it cannot be said that the 2^nd Defendant’s obligation has in any way been rendered more onerous by the Plaintiff’s delay.  Moreover, as discussed in paragraph 24 above, the 2^nd Defendant could well have “removed the cloud” by discharging the outstanding sum and prevent the interest from accruing.

28.  On either view of the construction of the Guarantee, I would come to the same conclusion that no prejudice has been occasioned to the 2^nd Defendant.

29.  For the above reasons, my view is that the 2^nd Defendant has not made out any arguable case that the Guarantee should be discharged.

The Collateral Agreement

30.  In his Affidavit made on 10 October 2005, the 2^nd Defendant asserted that the No-Action Agreement and the Guarantee were “gentlemen’s agreements” which were intended only to be used for internal record purposes of the Plaintiff.  According to him, Mr. Nakamura of the Plaintiff had represented that the Plaintiff would continue to supply products to the 1^st Defendant and give the 1^st Defendant full support and assistance to enable it to make repayment.  The 2^nd Defendant further asserted that Mr. Nakamura had verbally undertaken not to enforce the agreements against the 1^st or the 2^nd Defendant in the event of default in repayment.

31.  Mr. Au argued that these circumstances gave rise to a “collateral oral agreement” to the effect that the Plaintiff would not enforce the No-Action Agreement and the Guarantee.  He stressed the fact that the Plaintiff did not demand the 1^st Defendant for repayment of the outstanding balance until April 1999, and that even after April 1999 there was yet another substantial period of inactivity before the commencement of the present Action in 2003, were entirely consistent with the existence of the collateral agreement.  Mr. Au also emphasized the absence of explanation for the inaction on the part of the Plaintiff.

32.  As Mr. James rightly pointed out, the veracity of the “collateral oral agreement” must be examined in context of the following undisputed facts: first, undeniably, substantial sums were due and payable by the 1^st Defendant as of July 1996; secondly, the agreement and the Guarantee in question were executed following a demand for repayment by the Plaintiff’s solicitors in May 1996 with a threat of legal proceedings failing compliance with the demand; and thirdly, the argument of the non-binding nature of the agreements and the promise of non-enforcement had hitherto never been raised in response to any of the demands for repayment by the Plaintiff made at various points in time – September, October, December 1996, February 1997 and later April 1999.  Perhaps most importantly, this argument is a radical departure from the 2^nd Defendant’s Defence, which was professionally prepared on his behalf.  It has always been the 2^nd Defendant’s case, and it still is, that the Plaintiff’s cause of action on the Guarantee accrued sometime in 1996 or 1997, and that it was the Plaintiff’s duty to take enforcement action promptly after default occurred.  I am particularly troubled by the complete absence of explanation as to why these assertions, plainly contradictory to the case he previously advanced, have only emerged for the first time in his evidence in October 2005.  Also significantly, the new assertions were advanced only after the Plaintiff’s application for summary judgment. 

33.  I would also add that when the 2^nd Defendant referred to the No-Action Agreement and the Guarantee in his Affidavit and described them as “gentlemen’s agreements” in paragraphs 6 and 7, no mention was made of any verbal undertaking by Mr. Nakamura that the agreements would not be enforced.  Instead, in paragraphs 6 and 7, the references to verbal undertaking related only to the continuing supply of products.  According to the Affidavit, the alleged promise of not taking legal action was apparently only made in about March 1997 when the 1^st Defendant was allegedly asked by Mr. Nakamura to give the Plaintiff 12 post-dated cheques: paragraphs 10 and 11.  The presentation of the evidence in the Affidavit is clearly unsatisfactory as to whether the alleged verbal undertaking of non-enforcement was given at the time of the “gentlemen’s agreements”, or subsequently in about March 1997, or both.  This undoubtedly further undermines the credibility of the alleged “collateral oral agreement”.

34.  To the extent that the 2^nd Defendant is asserting that the verbal undertaking of non-enforcement was given in March 1997 as a result of the Plaintiff’s failure to honour its promise to continue with the supply of the products, such assertion is open to the same criticisms as above discussed (except references to absence of response to the demands made before March 1997). 

35.  In assessing the veracity of these new assertions, I have taken into consideration the long intervals between the accrual of the Plaintiff’s cause of action, the demands for repayment and the commencement of the present Action, and Mr. Au’s criticism as to the inadequacy of the explanation of delay by the Plaintiff.  Notwithstanding the eloquence with which those arguments were advanced, I am not persuaded that the new assertions were credible or believable to warrant a trial of those questions.

Conclusion

36.  The Plaintiff is entitled to summary judgment in respect of the sum of $2,346,450, and interest at the rate of 1% above HSBC’s prime lending rate applicable from time to time from the date of the Writ to the date of this judgment, and thereafter at judgment rate until payment.

37.  On the question of the 2^nd Defendant’s liability for contractual interest (that is, the claim for $1,363,512.45), as neither party has asked for a determination of the question by way of Order 14A, I would grant the 2^nd Defendant unconditional leave to defend that part of the claim.

38.  As the Plaintiff has been successful in relation to the principal part of its claim, I would make an order nisi that the 2^nd Defendant should bear three-quarters of the Plaintiff’s costs of this application.